BASEL II PILLAR 3 ANNUAL DISCLOSURES YEAR Page 0

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1 s BASEL II PILLAR 3 ANNUAL DISCLOSURES YEAR-2012 Page 0

2 Table of contents 1 Scope of application Capital structure Capital adequacy Credit risk Standardized approach and supervisory risk weights Credit risk: Disclosures for portfolios subject to IRB approaches Credit risk mitigation General disclosure for exposure related to counter-party credit risk Securitization Market Risk: Disclosure for banks using standaridised approach Market Risk: Disclosure for banks using internal models approach (IMA) for trading portfolios Operational Risk Equities: Disclosure for banking book positions Commission rate risk in the banking book Abbreviations used 20 List of tables Table 2, (b) to (e) Capital structure...5 Table 3, (b) Credit risk exposures and capital requiremnts...6 Table 3, (d) Capital requirements for market risk...7 Table 3, (e) Capital requirements for operational risk...7 Table 3, (f) Capital adequacy ratios...7 Table 4, (b) Credit risk expsosure....8 Table 4, (c) Credit risk exposure by Geographic area... 9 Table 4, (d) Credit risk exposure by Industry sector Table 4, (e) Credit risk exposure by residual contractual maturity Table 4, (f) Impaired Loans, Past due Loans and allowances Table 4, (g) Impaired Loans, Past due Loans and allowances by Geographic area Table 4, (h) Reconciliation of changes in the allowances for loan impairment Table 5, (b) Allocation of exposures to risk buckets Table 7, (b) & (c) Credit risk exposure covered by CRM Table 10, (b) Level of Market risk in terms of capital requirements Table 13, (b) Value of Equity investments Table 13, (c) Types and nature of equity investments Table 13, (d) & (e) Gains/Losses etc., on equity investments Table 13, (f) Capital requirements on equity investments Page 1

3 1. Scope of Application a) Scope The Basel II disclosures contained herein relate to Saudi Hollandi Bank and its subsidiaries Saudi Hollandi Capital, Saudi Hollandi Real Estate Company and Saudi Hollandi Insurance, hereinafter collectively referred to as the Group, for the period ended December 31, These are compiled in accordance with the Saudi Arabian Monetary Agency (SAMA) regulations on Implementation of New Capital Adequacy Framework Pillar 1 Minimum capital requirements Basel II requires risk-weighted assets (RWAs) to be calculated for credit, market and operational risk with various approaches available to banks, with differing levels of sophistication. Minimum capital requirements are calculated as 8% of RWAs. The Group applies the standardized approach for calculating RWAs. The capital charge for market risk, is based on a building-block approach. The capital charge for each risk category is determined separately. Within the commission rate and equity position risk categories, separate capital charges for specific risk and the general market risk arising from debt and equity positions are calculated. The Group is also required to calculate a capital charge to cover operational risk, which is calculated by applying a beta by activity to the average income that was achieved in the previous three years by the Group. Pillar 2 Supervisory review process Pillar 2 requires banks to undertake a comprehensive assessment of their risks and to determine the appropriate amounts of capital to be held against these risks where other suitable mitigants are not available. This risk and capital assessment is commonly referred to as the Internal Capital Adequacy Assessment Plan (ICAAP). The range of risks that are covered by the ICAAP is much broader than Pillar 1, which covers only credit, market and operational risk. The risks such as liquidity, concentration, strategic, reputational etc., are covered under Pillar 2. The Group has developed an ICAAP framework which closely integrates the risk and capital assessment processes, and ensures that adequate levels of capital are maintained to support the Group under stressed conditions. The Group has formed various committees to oversee the various risks it is exposed to: The Asset and Liability Management Committee is responsible for the establishment of and compliance with policies relating to the management of balance sheet risks. The Board has delegated limits on credit and market risk to the Head Office Credit Committee (HOCC). Operational Risk Management (ORM) is a unit within the risk function, which is responsible for identifying, assessing, monitoring and controlling/mitigating operational risk throughout the Bank in conjunction with all business units. The ICAAP framework has been designed to be applied consistently across the organisation to meet the Pillar 1 and Pillar 2 requirements of the regulator. Page 2

4 The ICAAP is followed by in-depth discussions between the Group and SAMA on the appropriate capital levels (this second stage is called the Supervisory Review and Evaluation Process or SREP). Pillar 3 Market discipline Pillar 3 aims to provide a consistent and comprehensive disclosure framework that enhances comparability between banks and further promotes improvements in risk practices. The information provided here has been reviewed and validated by senior management and is in accordance with the rules in force at the time of publication, covering both the qualitative and quantitative items. In accordance with SAMA regulation, the Group publishes the Pillar 3 quantitative disclosures on a semiannual basis and both qualitative & quantitative disclosures on an annual basis in its website as soon as is practical after the Group announces its annual results. b) Basis of consolidation The consolidated financial statements are prepared in accordance with Accounting Standards for Financial Institutions promulgated by SAMA and International Financial Reporting Standards issued by the International Accounting Standards Board. The Group prepares its consolidated financial statements to comply with the Banking Control Law, the provisions of Regulations for Companies in the Kingdom of Saudi Arabia and the Bank s Articles of Association. The basis of consolidation for accounting purposes is described in note 3(a) to the Notes to the consolidated financial statements of the Annual accounts c) Capital transferability between legal entities Statutory restriction SHB is required to transfer at least 25% of its net profit to statutory reserves before declaration of any dividend for the year until the amount of statutory reserves equals the paid up capital of the bank. Regulatory prescription SAMA has prescribed a minimum 8% Capital adequacy ratio which is in line with Basel II requirements. 2. Capital structure The Group is well capitalised with a Tier 1 capital ratio of 12.4 percent (2011:13.2 percent) and a total capital ratio of 17.6 percent (2011: 16.6 percent). For regulatory purposes, capital is categorised into two main classes. These are Tier 1 and Tier 2, which are described below. Tier 1 capital Tier 1 capital consists of ordinary share capital, statutory reserves, general reserves, retained earnings and fair value reserves. The ordinary share capital is the authorized, issued and fully paid up share capital of the bank, which consists of million shares of SAR 10 each (2011: million shares of SAR 10 each). The local and foreign ownership structure of the Group s share capital has remained unchanged during It is as follows: Saudi Shareholders 60% ABN Amro Bank N.V (The Netherlands) 40% Page 3

5 Tier 2 capital Tier 2 capital comprises the following: a) Reserves included under Tier 2 comprise balances that are available to meet unidentified impairments. These reserves are considered as Tier 2 capital up to a maximum of 1.25 per cent of the total risk-weighted assets as at December 31, The Reserves also includes the staff share plan reserve elaborated in note 37 to the annual financial statements for the year ended 31 December b) Subordinated debt includes the following debt securities: (i) (ii) (iii) On 26 November 2012, the Group issued SAR 1,400 million unsecured subordinated Mudaraba Certificates (the Certificates), due in The Group may at its option, but subject to the prior written approval of SAMA redeem the Certificates at their redemption amount at the end of 2017 or at the end of each calendar year thereafter until 2019, or in the event of certain changes affecting taxation and regulatory capital treatment of these Mudaraba Certificates. On 30 December 2009, the Group issued SAR 725 million unsecured subordinated Mudaraba Certificates (the Certificates), due in 2019, through public offer. The Group may at its option, but subject to the prior written approval of SAMA redeem the Certificates at their redemption amount at the end of 2014 or at the end of each calendar year thereafter until 2018, or in the event of certain changes affecting taxation and regulatory capital treatment of these Mudaraba Certificates. On 29 December 2008, the Group issued SAR 775 million unsecured subordinated Mudaraba Certificates (the Certificates), due in The Group may at its option, but subject to the prior written approval of SAMA redeem the Certificates at their redemption amount at the end of 2013 or at the end of each calendar year thereafter until 2017, or in the event of certain changes affecting taxation and regulatory capital treatment of these Mudaraba Certificates. These borrowings are of initial maturity of not less than 5 years and are progressively discounted as per the SAMA guidelines, based on their residual maturity. The total amount of subordinated debts that can be considered for tier 2 cannot exceed 50% of tier 1. Regulatory deductions SAMA requires deductions and prudential filters to be applied in calculating capital for regulatory purposes. Investments in material holdings Insurance organisations: The Group has a 20% holding in Wataniya Insurance company. Since it exceeds the threshold limit of 10% stipulated by SAMA, the investment amount of SAR 20 million less the impairment amount of SAR 1.95 million is deducted from Core Tier 1 and Tier 2 capital in equal proportions. Page 4

6 The table below summarises the consolidated capital position of the Group. Capital Structure (Table 2, (b) to (e)) (Figures in SAR 000's) Components of Capital Amount Core capital - Tier 1: Eligible paid-up share capital 3,969,000 Eligible reserves 2,835,726 Retained earnings 1,051,287 Other reserves (5,790) Deductions from Tier 1: Significant minority investments at 10% and above - Insurance organizations (9,026) Total Core Tier 1 capital 7,841,197 Supplementary capital - Tier 2: Staff share plan reserve 11,229 Subordinated loan capital 2,900,000 Qualifying general provisions 376,000 Deductions from Tier 2: Significant minority investments at 10% and above - Insurance organizations (9,026) Total Tier 2 capital 3,278,203 Total capital base 11,119, Capital adequacy SHB determines an adequate level of capital to cover the risks it is exposed to and to support its current and forecast growth. Within SHB, capital adequacy is assessed in the ICAAP. The ICAAP is required as part of the Basel II Pillar II capital adequacy regime. It aligns capital levels to all risks (Pillar 1 & Pillar 2) that the Group is exposed to, and outlines processes by which the Group identifies, measures, monitors and manages risks, thereby ensuring that the Group s capitalization is appropriate. Capital Planning and Targets The ICAAP describes the Group s business strategy, its forecasts for risk weighted assets, its appetite and its assessment of the specific risks it is exposed to, how it intends to mitigate those risks and the capital it allocates to these risks. As such, the ICAAP is a crucial element of the Group s strategic decision making, and the strategy is continuously aligned with the ICAAP. The ICAAP contains, in detail the following elements: a) The risks the Group is exposed to and how it measures, monitors and manages those risks; b) A calculation of internal capital requirements (including Pillar 1 and Pillar 2 risks) in light of the business plans and the risks the Group is exposed to; c) A calculation of the capital generated internally or externally and the assessment of the adequacy of the Group's capital and buffers vis-à-vis the capital requirements; and d) A stress test of the Group's capital buffer. In addition to the annual ICAAP review, the bank has a capital management plan, updated monthly and monitored closely. Page 5

7 The following sections cover the Pillar 1 risks, which the Group is exposed to and the capital requirements for the same. a) Risk Exposure and Risk Assessment under Pillar 1 The following table details the types of exposures in each asset class. Basel Asset Class Corporate Sovereign Bank Residential Mortgage Qualifying Revolving Retail Other Retail Equity Typical Types of Exposure Individually rated and managed exposures not covered under other categories - mainly lending and off-balance sheet facilities provided to larger companies, partnerships and other legal entities Exposures to sovereigns and central banks. Includes direct exposures e.g. bond holdings Exposures to non-group bank counterparties. Includes bond holdings and deposits with other banks, trade finance exposures, guarantees provided by other banks and derivatives Retail exposures secured by residential properties Retail managed consumer credit card exposures Other Assets Mainly fixed assets and prepayments The Risk assessment process is elaborated under disclosure 4. Retail managed exposures other than mortgage and qualifying revolving - includes personal loans, consumer and small business leasing, retail small business lending Holdings of third party equities where not consolidated or deducted from capital The Group applies the standardised approach for calculation of credit risk under Pillar 1. The following table shows the amount of Risk weighted exposures by portfolio and the capital requirements for the same. Amount of Exposures Subject To Standardized Approach of Credit Risk and related Capital Requirements (Table 3, (b)) (Figures in SAR 000's) Portfolio Amount of exposures Capital requirements Sovereigns and central banks: 18,248, SAMA and Saudi Government 17,569,035 - Others 679, Multilateral Development Banks (MDBs) 136,225 - Public Sector Entities (PSEs) - - Banks and securities firms 4,056, ,786 Corporates 50,038,597 3,950,823 Retail non-mortgages 5,902, ,893 Mortgages 1,300, ,066 Residential 1,300, ,066 Commercial - - Securitized assets - - Equity 33,291 2,663 Others 1,890, ,864 Total 81,607,244 4,706,524 The Group applies the Standardised approach to calculate the capital charge to cover market risk, which uses a building-block approach. The capital charge for each risk category is determined separately. Within the Page 6

8 commission rate and equity position risk categories, separate capital charges for specific risk and the general market risk arising from debt and equity positions are calculated. The following table shows the capital requirements for various risks. Standardised approach Capital Requirements For Market Risk (Table 3, (d)) (Figures in SAR 000's) Equity Foreign Interest Commodity Total capital position exchange rate risk risk requirements risk risk 23,079-36,015-59,094 The Standardised Approach for operational risk capital calculation applies a beta to the average income that was achieved in the previous three years by the Group. The following table shows the capital requirements for operational risks. Capital Requirements for Operational Risk (Table 3, (e)) (Figures in SAR 000's) Particulars Capital requirements Standardised approach 290,027 Total 290,027 Capital Adequacy Ratios (TABLE 3, (f)) Particulars Total capital ratio % Tier 1 capital ratio Top consolidated level 17.6% 12.4% 4. Credit Risk Credit risk is the risk of financial loss from the failure of a customer to fully honour the terms of its contract with the Bank. Losses can arise from: Funded lending: i.e. providing loans, overdrafts, credit cards; Non-funded: contingent products such as Trade Finance facilities and FX products. Non-funded risk can also give rise to settlement risk which can occur from any transaction which requires assured payment of funds on a given date. Credit risk responsibility is vested with the Board, delegated to the HOCC, an approval authority up to a certain limit fixed per obligor by the Board. The granting of credit to customers is a core business of SHB and accounts for a major portion of the Bank's balance sheet and profitability and hence the major contributor to the Bank s risk assets. Credit policies The Credit Policy and Procedures Manual is subject to annual review, endorsed by HOCC and approved by the Board. Page 7

9 Concentration risk Concentrations of credit risk arise when a number of counterparties are engaged in similar business activities or activities in the same geographic region, or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political or other conditions. Concentrations of credit risk indicate the relative sensitivity of the Bank s performance to developments affecting a particular industry or geographical location. The Bank seeks to manage its credit risk exposure through the diversification of lending activities to ensure that there is no undue concentration of risks with individuals or groups of customers in specific locations or businesses. Credit monitoring Credit limits are monitored by the business and control functions. In addition, regular credit portfolio reports are prepared and presented to the Board covering the corporate, retail and financial institutions portfolios. Credit risk exposures The following tables detail the Group s standardised credit risks by exposure class, geographic area, industry sector and residual maturity band. Credit Risk Exposure (Table 4, (b)) (Figures in SAR 000's) Portfolios Total gross credit risk exposure Average gross credit risk exposure over the period* Sovereigns and central banks: 18,248,943 15,866,303 SAMA and Saudi Government 17,569,035 15,219,851 Others 679, ,452 Multilateral Development Banks (MDBs) 136, ,211 Public Sector Entities (PSEs) - - Banks and securities firms 4,056,562 4,442,867 Corporates 50,038,597 48,151,965 Retail non-mortgages 5,902,358 5,541,537 Mortgages 1,300, ,978 Residential 1,300, ,978 Commercial - - Securitized assets - - Equity 33,291 34,138 Others 1,890,440 2,136,314 Total 81,607,244 77,085,313 * Quarterly averages for the year Page 8

10 Portfolios Sovereigns and central banks: Geographic Breakdown (Table 4, (c)) (Figures in SAR 000's) Saudi Arabia Other GCC & Middle East Europe Geographic area North America South East Asia Others countries Total 17,569, , ,248,943 SAMA and Saudi Govt. 17,569, ,569,035 Others - 679, ,908 Multilateral Development Banks (MDBs) Public Sector Entities (PSEs) , , Banks and securities firms 1,100, ,998 1,662,195 99,319 1, ,763 4,056,562 Corporates 49,152, ,022 2, ,038,597 Retail non-mortgages 5,902, ,902,358 Mortgages 1,300, ,300,828 Residential 1,300, ,300,828 Commercial Securitized assets Equity 33, ,291 Others 1,890, ,890,440 Total 76,949,117 2,170,928 1,800,633 99,319 1, ,763 81,607,244 Page 9

11 Portfolios Sovereigns and central banks: SAMA & Saudi Government Govt and quasi govt. Banks and other financial institutions Agricultu re and fishing Industry Sector Breakdown (Table 4, (d)) (Figures in SAR 000's) Manufacturing Mining and quarrying Electricity, water, gas and health services Industry sector Building and construction Commerce Transpor tation and communi cation Services Consumer loans and credit cards 18,248, ,248,943 17,569, ,569,035 Others 679, ,908 Multilateral Development Banks (MDBs) Public Sector Entities (PSEs) - 136, , Banks and sec firms - 4,056, ,056,562 Corporates 1,354,631 1,302, ,106 10,782, ,470 2,175,383 12,675,767 13,470, ,022 4,471,596-1,981,321 50,038,597 Retail nonmortgages ,902,358-5,902,358 Mortgages ,300,828-1,300,828 Residential ,300,828-1,300,828 Commercial Securitized assets Equity ,291 33,291 Others ,890,440 1,890,440 Total 19,603,574 5,495, ,106 10,782, ,470 2,175,383 12,675,767 13,470, ,022 4,471,596 7,203,186 3,905,052 81,607,244 Others Total Page 10

12 Residual Contractual Maturity Breakdown (Table 4, (e)) (Figures in SAR 000's) Maturity breakdown Portfolios Less than 8 days 8-30 days days days days 1-3 years 3-5 years Over 5 years Total Sovereigns and central banks: SAMA and Saudi Govt. 9,119,969 2,280 5,646,517 2,013,104 70, , , ,533 18,248,943 9,119,969 2,280 5,646,517 2,013,104 31,187 88, , ,156 17,569,035 Others , , , ,908 Multilateral Development Banks (MDBs) Public Sector Entities (PSEs) Banks and securities firms , , , , , , , ,755 92,540 93,871 4,056,562 Corporates 5,023,634 7,434,010 3,855,640 8,900,229 6,787,549 6,910,631 8,030,696 3,096,209 50,038,597 Retail non-mortgages 940,578 30, , ,740 3,057,545 1,367,830 40, ,532 5,902,358 Mortgages 3, ,750 11,737 1,283,484 1,300,828 Residential 3, ,750 11,737 1,283,484 1,300,828 Commercial Securitized assets Equity 33, ,291 Others 693, , ,117,368 1,890,440 Total 16,694,785 8,182,533 10,307,334 11,308,639 10,378,278 9,946,596 8,387,083 6,401,996 81,607,244 Page 11

13 Impairment assessment methodology In determining whether an impairment loss should be recorded, the Bank makes judgements as to any collateral held and whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows. This evidence may include observable data indicating there has been an adverse change in the payment status of borrowers in a group. Management uses estimates based on historical loss experience for loans with credit risk characteristics and objective evidence of impairment similar to those in the portfolio when estimating its cash flows. The methodology and assumptions used for estimating both the amount and the timing of the future cash flows are reviewed regularly to reduce any differences between loss estimates and actual loss experience. The following tables sets out the details of impaired and defaulted loans and the provisions the Group is carrying as at the reporting date 31 December Industry sector Impaired Loans, Past Due Loans and Allowances (Table 4, (f)) (Figures in SAR 000's) Impaired loans Defaulted Less than 90 Ageing of Past Due Loans (days) Over 360 Balance at the beginning of the period Specific allowances Charges during the period Charge-offs during the period Balance at the end of the period General allowances Government and quasi government Banks and other financial institutions Agriculture and fishing 21,488 5,284 5, ,310 - (1,822) 21,488 - Manufacturing 72,228 14,972 14, ,817 4,300 (49,889) 72, Mining and quarrying Electricity, water, gas and health services 8, ,367 - (67) 8,300 - Building and construction 129,487 24,155 17,990 6, ,214 48,885 (34,612) 129,487 - Commerce 369,069 55,783 55, ,395 54,366 (99,692) 369,069 - Transportation and communication (178) - - Services 7,787 3,508 3, ,396 - (20,609) 7,787 - Consumer loans and credit cards 46,680 52,347 52, , ,233 (78,288) 54,280 19,833 Others 67, ,865 43,373 (15,329) 64, ,167 Total 722, , ,183 6, , ,158 (300,486) 727, ,000 The geographical distribution of impaired loans, past due loans and allowances as at 31 December 2012 are provided hereunder: Impaired Loans, Past Due Loans And Allowances (Table 4, (g)) (Figures in SAR 000's) Geographic area Impaired loans Less than 90 Aging of Past Due Loans (days) Over 360 Specific allowances General allowances Saudi Arabia Total 722, ,183 6, , , , ,183 6, , ,000 Page 12

14 The following table sets out the movements in the Group s total individual and portfolio impairment provisions against loans and advances. Reconciliation Of Changes In The Allowances For Loan Impairment (Table 4, (h)) (Figures in SAR 000's) Particulars Specific allowances General allowances Balance, beginning of the year 772, ,771 Charge-offs taken against the allowances during the period (300,486) - Amounts set aside (or reversed) during the period 255,158 79,229 Transfers between allowances - - Balance, end of the year 727, , Standardized approach and supervisory risk weights Qualitative disclosures For portfolios under the standardized approach, External Credit Assessment Institutions risk assessments are used by SHB as part of the determination of risk weightings: Ratings for banks have been sourced from Standard and Poor s Ratings Group, the Fitch Group and Moody s. Credit ratings of all exposures are individually determined from the above credit rating agencies and mapped to the exposures assigning a risk weight according to the supervisory tables. Where the obligors have not yet obtained such a rating, the exposure is taken as unrated and appropriate risk weights applied. The Group has not adopted any of the IRB approaches. The alignment of alphanumeric scales of each agency to risk buckets: Alphanumeric scales: Moody s Standard and Poor s Fitch Aaa AAA AAA Aa1 AA+ AA+ Aa2 AA AA Aa3 AA- AA- A1 A+ A+ A2 A A A3 A- A- Baa1 BBB+ BBB+ Baa2 BBB BBB Baa3 BBB- BBB- Ba1 BB+ BB+ Ba2 BB BB Page 13

15 Ba3 BB- BB- B1 B+ B+ B2 B B B3 B- B- Caa1 CCC+ CCC+ Caa2 CCC CCC Caa3 CCC- Ca CC C C WR D NR Claims on sovereigns and their central banks Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated Risk Weight 0% 20% 50% 100% 150% 100% Claims on Banks and Securities Firms SAMA requires banks operating in Saudi Arabia to use Option 2 for risk-weighting claims on banks and securities firms. Credit Assessment AAA to AA- A+ to A- BBB+ to BBB- BB+ to B- Below B- Unrated Risk Weight under Option 2 20% 50% 50% 100% 150% 50% Risk weight for short-term claims under Option % 20% 20% 50% 150% 20% Multilateral Development Banks A 0% risk weight has been applied for the MDB s approved by SAMA. Claims on public sector entities (PSEs) As per Option 2. Claims included in the regulatory non-mortgage retail portfolios A 75% risk weight to be assigned to such exposures. Claims on corporate Credit Assessment AAA to AA- A+ to A- BBB+ to BB- Below BB- Unrated Risk Weight 20% 50% 100% 150% 100% Claims secured by Residential Mortgages A 100% risk weight to be applied to such claims. Page 14

16 Claims secured by Commercial Real Estate A 100% risk weight to be applied to such claims. Past due loans The unsecured portion of any loan that is past due for more than 90 days or rescheduled, net of specific provisions (including partial write-offs), have been risk weighted as follows: Level of Provisioning Risk weight% Upto 20% 150 above 20% 100 Other assets The standard risk weight for all other assets will be 100% except cash & cash equivalents which are risk weighted at 0%. Other assets include various transmission accounts, accrued receivables, cash and cash equivalents and fixed assets. The allocation of credit risk exposures on the basis of risk buckets are provided hereunder: Allocation Of Exposures To Risk Buckets (Table 5, (b)) (Figures in SAR 000's) Risk buckets Particulars Other 0% 20% 35% 50% 75% 100% 150% risk Unrated TOTAL weights Sovereigns and central banks: 18,222,112 26, ,248,943 SAMA and Saudi Government 17,569, ,569,035 Deducted Others 653,077 26, ,908 Multilateral Development Banks 136, ,225 (MDBs) Public Sector Entities (PSEs) Banks and - securities firms - 1,079,916-2,390, , ,056,562 - Corporates - 522, ,076-49,039,441 6,227-50,038,597 Retail nonmortgages ,164, ,596-5,902,358 - Mortgages ,300, ,300,828 Residential ,300,828-1,300,828 - Commercial Securitized assets Equity ,291-33,291 Others 395, ,495,189-1,890,440 - TOTAL 18,753,588 1,629,599-2,860,704 5,164,763 53,192,363 6,227-81,607,244 Page 15

17 6. Credit Risk: Disclosures for portfolios subject to IRB approaches Not Applicable 7. Credit Risk Mitigation The Main Types of Collateral Taken by SHB Collateral is used to mitigate credit risk, as an alternative source of repayment in the event the counterparty cannot meet its contractual obligations through its operating cash flow or by refinancing. Types of collateral typically accepted by SHB include, but are not limited to: - Cash and lien over deposits; - Real estate security over residential, commercial, industrial or rural property; - Charges over specific plant and equipment; - Charges over listed shares, bonds and securities; and - Guarantees and pledges. In some cases, such as where the customer risk profile is considered very sound (or by the nature of the product, for instance small limit products such as credit cards), a transaction may not be collateralized. Credit policy sets out the acceptable types of collateral, and also has a process by which additional instruments and/or asset types can be considered for approval. Besides tangible security and guarantee support as described above, credit risk is further mitigated by prudent transaction structuring and documentation. For example, in some transactions risk can be mitigated by lending covenants, or political risk insurance. Policies and Processes for Collateral Valuation and Management SHB has established policies and processes around collateral valuation and management. The concepts of legal enforceability, certainty and accurate valuation are central to collateral management. In order to achieve legal enforceability and certainty, SHB has standard collateral instruments, and, where possible, security interests are registered. In order to rely on the valuation of collateral assets, SHB has developed comprehensive rules around acceptable types of valuations (including who may value an asset), the frequency of revaluations and standard loan-to-value ratios for typical asset types. Upon receipt of a new valuation, the information is used to reassess the adequacy of the collateral. In the case of impaired assets, collateral valuations are considered when setting and reviewing provisions. Credit Risk Exposure Covered By CRM (Table 7, (b) and (c)) (Figures in SAR 000's) Portfolios Eligible financial collateral Covered by Guarantees / credit derivatives Corporates 388,506 - Total 388,506 - Page 16

18 8. General disclosure for exposure related to counter-party credit risk Counterparty credit risk is the risk that the Group s counterparty in a foreign exchange, commission rate, commodity, equity or credit derivative contract defaults prior to maturity date of the contract and that the Group at the time has a claim on the counterparty. The Group calculates its counterparty credit risk under both trading and banking book exposures by assigning risk weights to exposure types, which are as follows: a) Securities financing transactions (e.g. reverse repo) - trading and banking book b) Over the counter (OTC) derivatives trading and banking book Capital requirement is determined on above exposures based on the same methodology as credit risk and is reported separately for risk assessment. 9. Securitisation The Group is not involved in any securitisation deals, hence the requirement for qualitative and quantitative disclosures does not arise. 10. Market Risk: Disclosure for Banks using standardized approaches Market risk is the risk that the fair value or future cash flows of financial instruments will fluctuate due to changes in market variables such as commission rates, foreign exchange rates, and equity prices. The Bank classifies exposures to market risk into either trading or banking-book Risk identification Since January 1, 2008, SHB, like all banks in the Kingdom, is Basel II Standardised Approach compliant with respect to market risk reporting and calculation of capital Risk measurement The following table shows the capital requirements for various market risks as at 31 December 2012, based on the standardised approach. Level Of Market Risks In Terms Of Capital Requirements (Table 10, (b)) (Figures in SAR 000's) Equity Commissio Foreign Commodity position n rate risk exchange risk risk risk Total Capital requirements 23,079-36,015-59,094 SHB uses a range of measures to manage market risk. These include a comprehensive framework of market risk limits by risk factor and business line, ranging from specific dealer stop loss limits, to sensitivity limits such as present value of a basis point movement of commission rates and open currency position limits as well as Value at Risk (VaR) limits. SHB s VaR model uses an historical simulation approach to estimate the potential loss from adverse market movements over a specified time horizon and for a given (high) level of confidence. Market risk stress testing is also carried out in order that management is aware of and able to take any action necessary to mitigate, losses that could arise from extreme scenarios. Page 17

19 11. Market Risk: Disclosure for banks using internal models approach (IMA) for trading portfolios Not applicable. 12. Operational Risk Operational risk is the risk of direct or indirect loss due to an event or action resulting from inadequate or failed internal processes, people and systems, or from external events. SHB s approach has been to adopt the Standardized Approach requirements for Operational Risk as defined by the Basel II framework. Objective Operational risks are inherent to all business activities. It is the Group s objective to minimize exposure to such risks, subject to cost tradeoffs. This objective is met through a framework of policies and procedures that ensure risk identification, assessment, control and monitoring. Governance Structure Operational Risk Management (ORM) is a unit within the risk function that is managed by the Head of Operational Risk Management who reports directly to the CRO. ORM is guided and directed by the ORM Committee, at the request of SHB's Board of Directors. Risk identification SHB follows a best practice methodology of risk assessments and control evaluations for the identification of inherent operational risks. ORM manages operational risk for new or changed initiatives/products through the Operational Risk Assessment Procedure (ORAP) and the policy for this is set out in the ORAP Policy Manual. All operating losses and issues are recorded in the Bank's Operational Loss Database by the relevant business units following verification. Operational risks are identified and assessed using the Risk and Control Self-Assessment and Key Risk Indicator tools. Risk Measurement Measurement of operational risk is managed primarily through a Bank Operational Loss Database. 13. Equities: Disclosures for banking book positions All Equity investments are classified as Available for sale. Available-for-sale investments are those intended to be held for an unspecified period of time, which may be sold in response to needs for liquidity or changes in commission rates, exchange rates or equity prices. Investments, which are classified as available for sale are subsequently measured at fair value. For an available-for-sale investment where the fair value has not been hedged, any gain or loss arising from a change in its fair value is recognized directly in Other reserves under Shareholders equity. On derecognition, any cumulative gain or loss previously recognized in shareholders equity is included in the consolidated statement of income for the period. Equity investments classified under available-for-sale investments whose fair value cannot be reliably measured are carried at cost. The following tables shows the equities investment in banking book as at 31 December 2012 Value Of Investments (Table 13, (b)) Figures in SAR 000's Un-quoted investments Quoted investments Value disclosed in Financial Statements Fair value Value disclosed in Financial Statements Fair value Publicly quoted share values (if materially different from fair value) Investments 4,188 4,188 29,103 29,103 - Page 18

20 Types And Nature of Investments (Table 13, (c)) (Figures in SAR 000's) Investments Publicly traded Privately held Banks and other financial institutions 29,103 1,250 Manufacturing - - Services - 2,938 Total 29,103 4,188 Gains / Losses Etc. (Table 13, (d) and (e)) (Figures in SAR 000's) Particulars Amount Unrealized gains (losses) included in Capital (13,391) Total unrealized gains (losses) (13,391) Capital Requirements (Table 13, (f)) (Figures in SAR 000's) Equity grouping Capital requirements Banks and other financial institutions 2,428 Manufacturing - Services 235 Total 2, Commission rate risk in the Banking book Commission rate risk arises from the possibility that the changes in commission rates will affect either the fair values or the future cash flows of the financial instruments. The Board has established commission rate gap limits for stipulated periods. The Bank monitors positions daily and uses hedging strategies to ensure maintenance of positions within the established gap limits. The table shown under Note 31 b (i) to the financial statements 2012, depicts the sensitivity to a reasonable possible change in commission rates, with other variables held constant, on the Bank s statement of income or equity. The sensitivity of the income is the effect of the assumed changes in commission rates on the net commission income for one year, based on the floating rate non-trading financial assets and financial liabilities held as at December 31, 2012 including the effect of hedging instruments. The sensitivity of equity is calculated by revaluing the fixed rate available for sale financial assets, including the effect of any associated hedges as at December 31, 2012 for the effect of assumed changes in commission rates. The sensitivity of equity is analyzed by maturity of the asset or the hedging instrument. Page 19

21 Abbreviations used: CRM: Corporate Risk Management CRO: Chief Risk Officer HOCC: Head Office Credit Committee ICAAP: Internal Capital Adequacy Assessment Plan ORAP: Operational Risk Assessment Procedure ORM: Operational Risk Management RWA: Risk Weighted Assets SAMA: Saudi Arabian Monetary Agency SHB: Saudi Hollandi Bank VaR: Value at risk Page 20